Consensus Algorithms — The Pros and The Cons of PoW and PoS

If you are someone who is into cryptocurrencies and blockchain, at some point, you might have wondered what drives this decentralized ledger technology without the need for any central authority or a set of intermediaries. Or else, what makes Bitcoin the most vouched after digital asset beyond the limited realms of either paper or plastic money?

The mechanism that operates behind the curtains of the supremely utilitarian tech is Consensus Mechanism. A consensus mechanism is crucial in the effortless working of any blockchain. Via the consensus algorithm, transactions are validated and confirmed over the blockchain, without any third-party interference.

How Does a Consensus Mechanism Work?

A blockchain is an interlinked network of nodes on which transactions are recorded. The more the number of nodes supporting a blockchain, the greater would be its security. Even if any node or participant drops out, the network continues to operate seamlessly. This is due to the fact that the information recorded on the nodes cannot be altered or deleted, only new nodes can be added to the pre-existing network. Since all the nodes function independently, a predefined set of rules, agreed upon by all the nodes, determines which new node would be added to the network. This set of rules is what we call a consensus mechanism.

Currently, the Proof-of-Work (PoW) and Proof-of-Stake (PoS) consensus are the two most popular consensuses, PoW being the first and widely used consensus powering the likes of Bitcoin. While the PoS mechanism is steadily gaining traction as a better consensus over the former. Let’s have a head-on comparison of the two consensus algorithms.

What is PoW Algorithm?

Introduced in 2008 along with Bitcoin, PoW remains the widely accepted mechanism for cryptocurrencies. It operates on a public blockchain to power Bitcoin and many other cryptocurrencies. The consensus involves solving complex ‘cryptographic puzzles’. As soon as a transaction starts, miners, using their supercomputers, try and solve the puzzle that would tell them the next block or node that will be added to the network. The miner who succeeds in solving the puzzle first gets Bitcoins for his work along with a small fee.

Once the correct answer to the puzzle is found, a new node is formed and a suggestion is made to add it to the network. All the other nodes check the answer and approve the request instantaneously and a new block is added to the network. This completes one cycle of mining, immediately after, the next cycle begins.

Examples of cryptocurrencies, besides Bitcoin, using PoW consensus include Bitcoin Cash, Litecoin, Dogecoin, Ethereum Classic, etc. Ethereum has already switched over to the more efficient PoS consensus. Let’s understand its peculiarities first before we enter the wrestling arena.

What is Proof of Stake?

In the 2011 Forum Bitcointalk, a new mechanism was proposed to counter the inefficiencies and energy-intensive nature of the PoW consensus. The suggestion included giving voting rights to the users holding a bigger kitty of coins instead of the miners having more resources. This mechanism when came into being was called as Proof-of-Stake consensus.

A PoS consensus requires participants to ‘freeze’ the coins that they hold in their accounts. The consensus functions more like a lottery where the more coins a participant ‘freezes’ or stakes, the more is their chance to contribute to the network, given their economic share. The validation of the next block would then depend on the choice of the participants with the largest economic share. It also works on a public blockchain. The validators get processing fees but no new coins are rewarded for the services they render.

Examples of cryptocurrencies that use the PoS network include NXT, Lisk, Cardano, Tezos, Peercoin, blackcoin, etc.

PoW vs PoS: The Pros and Cons

#1 Energy Consumption

The idea behind the PoS consensus was well-intentioned to reduce the energy consumption of the PoW consensus. The PoW mechanism employs excess resources, expensive machines that worn out quickly, and the resultant heat produced. All these contribute to the carbon footprint.

The Proof of Stake consensus involves validators and not miners. Hence, the need for supercomputers and allied mining facilities are eliminated. Even Tesla disapproved of Bitcoin’s energy-intensive nature recently, after having bought themselves a major chunk of Bitcoin investment. Tesla suspended vehicle purchases in Bitcoin until the shift to more sustainable sources of energy is made.

#2 Speed and Scalability

The Proof of Stake consensus scores over Proof of Work when it comes to faster transactions. PoW-based blockchains, on average, take 10 minutes to complete a transaction. The miners need to solve the puzzle to find a new block this eats up much time. Also, In case of network congestion, the transaction fees steeply increase. While in PoS consensus transactions are validated much faster.

The PoW consensus is a highly scalable consensus mechanism, no doubt. But PoS mechanism performs better in terms of scalability too.

#3 Centralization

Blockchain protocols are distinct due to the decentralization they offer. The higher the number of nodes, the higher will be the decentralization. The PoS-based systems are under the threat of centralization much more than the PoW-based networks. We are aware of the economic phenomenon of The rich getting richer and vice-versa. Similarly, the PoS network has a tendency to be influenced by a few players holding the major economic share in terms of the number of coins staked by them.

Whereas, in PoW-based networks, the threat is less as more and more miners compete for the same reward on each transaction. However, we can not deny the monopoly that miners with expensive mining facilities can attain, as no common PC can be used to solve such complex problems, thus limiting the number of players.

#4 Stagnation

The Proof of Work consensus scores over the PoS consensus model in this regard too. In the PoS-based network, the validators profit from staking or freezing coins rather than spending them. This can stagnate the economy of the coin which might result in a decline in its value. While under the PoW-based network, miners have to spend heavily on computers and electricity. They cannot afford to keep the coins for the long term. This makes the market of the coin active as miners quickly sell the coins that they earn as rewards.

#5 Security

There are a considerably higher number of nodes in the PoW mechanism which makes it more secure and less prone to 51% attacks. While in the case of the PoS mechanism, the risk of such attacks increases as the economic share gets concentrated in a few hands.

We mustn’t ignore the fact that even under the PoW-based network, owing to the concentration of mining facilities, the risk of 51% attacks can’t be ignored. The PoS algorithm scores over the PoW algorithm in terms of its energy usage, cost-effectiveness, scalability, and faster transaction speed. While, the PoW algorithm scores in terms of decentralization, security, and vitality it offers to the coin. However, improved versions of the PoS algorithm such DPoS (delegated Proof of Stake) algorithms are trying to overcome the drawbacks of the PoS consensus. We are yet to achieve the full benefits of decentralization in the current consensus mechanisms, but we sure are getting there!